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The Six Factors That Drive Gold Prices

jeffriess
February 28, 2020
by Joseph Jeffriess, Market Analyst

Gold is considered to be a safe haven asset during periods of market volatility. However, other factors that directly affect the price of gold should be analysed when wanting to trade this particular commodity. Eightcap has summarised the six key factors that drive the price of gold, keep an eye on them when trading commodities CFDs with us.

Supply and Demand: Compared to other commodities, gold is always in supply with more being mined daily. The precious metal is indestructible and is also an excellent conductor of electricity. Gold tends to be melted down to a liquid format and then reused to manufacture other items. Normally when there is a surplus of supply, the value of the asset will also decrease. However, in this case, there will always be a demand for gold deriving mainly from the jewellery sector, this causes the price of gold to rise.

Central Banks: Gold prices can also go up and down because of Central Bank gold reserves. If foreign exchange reserves are at a surplus within the country and the health of the economy is maintained at a positive level, the Central Bank is normally inclined to reduce the amount of gold that it holds. The reason for this being that gold is considered to be a dead asset – meaning that it provides no returns when it is stored, therefore, the decision is made to sell.

The trouble when Central Banks try to sell gold is that it is normally at a time where traders are not wanting to buy the precious metal, which then drives the price down.

The Washington Agreement was formed in 1999 and came about at a time where there were problems around Central Banks selling gold, destabilising the market in the process, and drastically causing the price of gold to plummet. 15 European Central Banks at the time formed an agreement stating that they would limit the collective sales to 2,000 tonnes over the following five years, alternatively, this could also be spread out to 400 tonnes a year. In 2019, due to market maturity, Central Banks have reverted the Washington Agreement as they no longer see a need for it. Therefore, without further limitations on Central Bank gold sales, it will be interesting to see how the market reacts in the following years.

The U.S. Dollar: If the USD is weak this pushes the price of gold up and when the USD is strong then the price of gold drops. In times when the USD falls, other currencies tend to rise in value, during these periods there is also more demand for commodities such as precious metals.

Safe Haven Asset Flows: Gold is not directly influenced by political and economic factors like the FX market. An example of this was Brexit, during a certain period there was a phenomenal impact on the GBP due to parliamentary decisions and the outcome of the 2019 general election. During times of political crisis, many traders turn to gold as it holds value when there’s uncertainty in the market. Many traders will include gold in their portfolio as a form of a safe-haven currency.

Inflation: When inflation levels are high the value of certain currencies will drop, causing its price to fluctuate in the FX market. Therefore traders tend to hedge gold against inflation shocks, this is because gold’s value is considered to be stable during times of high inflation. Essentially as inflation levels rise so does the demand for gold, this then drives the price of gold up. It could be argued that it is investor fears over inflation that drives the price of gold. However, whilst it is treated as a safe haven asset, it is very volatile and will experience very strong price swings during certain years.

Interest Rates: The most common opinion from commodity traders is that interest rates have a bearish effect on gold prices. High-interest rates set by the Central Bank indicates that the country’s economy is healthy, which is another reason to anticipate gold prices to be suppressed.

 

Good trading from Eightcap.
All times are AEDT.